Concept And Accounting of Depreciation

Cost of Assets for Calculating Depreciation

While calculating the depreciation of an asset there are some factors we must keep in mind. These include the life of the asset. its scrap value and most importantly the cost of assets. So let us learn some more about this.

Depreciation of an Asset

All assets acquired for business purposes inevitably lose their monetary worth over the course of time. This happens due to factors like wear and tear and efflux of value. Even obsolescence due to technological advancements and depletion in the market value plays a big role in this regard.  This process of reducing the values of assets is subsequently called depreciation.

Before we learn about the process of gradual depreciation, it is pertinent to firstly note other important aspects. Let’s see how we can determine the cost of assets in the first place. Firstly, three important factors determine the depreciation of an asset:

  1. Cost of assets
  2. Its estimated useful life
  3. The scrap value at the end of its estimated useful life

Cost of Assets for Calculating Depreciation

It is most noteworthy to remember that the concept of depreciation applies only to tangible and fixed assets. These comprise of assets like buildings, vehicles, machinery and office equipment which contribute to the production of goods and services and are useful for a period of more than a year.

Cost of the Assets

In order to calculate how much the value of these assets has decreased due to depreciation, we first need to know their original costs. This is defined as the original price of the asset from which we can determine its depreciated value over the course of its useful life.

Cost of assets represents the monetary costs involved in acquiring, installing and commissioning assets. In simple words, it includes the money involved in purchasing assets and putting them to use for their purposes. For example, a machine’s cost includes its purchase cost, transportation expenses, and installation charges.

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What does the Cost of Assets include?

The cost of assets is generally perceived to be the money paid to buy it. In contrast, it involves a lot of other components as well. Accounting Standard 10 deals with the accounting of fixed assets. It says that the components of the costs of fixed assets include:

  • Purchase price,
  • Import duties and non-refundable taxes paid on it,
  • Freight and handling expenses,
  • Costs of dismantling, removing or clearing a site for installation,
  • Directly attributable cost of bringing the assets to working condition,
  • Costs of site preparation,
  • Initial delivery and handling costs,
  • Installation and assembly costs,
  • Costs of incurred in testing whether the asset is working properly, and
  • Professional fees as payable to architects or engineers for installation.

What does the Cost of Assets exclude?

We must not consider the following expenses while determining the cost of assets:

  • Costs incurred in opening or inaugurating new facilities,
  • Expenditure incurred in production for sale or captive consumption,
  • Expenditure for promotional activities, and
  • Administrative and other general overhead expenses.

Finally, after an asset comes into full operation, we should not consider any other cost it incurs towards its functioning as its acquisition costs. We can, however, include in their original costs all major improvements or upgrades. They are even more important as they improve the useful life of the assets or their production capacity.

Solved Question on Cost of Assets

Question: Prime Auto Ltd. is an automobile company that has just acquired a range of robotic components for assembling vehicles. Which of the following expenses will be considered while determining its acquisition cost?

  1. Purchase price
  2. Import duty paid
  3. Transportation costs
  4. The cost incurred in advertising features of the components
  5. Installation charges
  6. The cost incurred in providing electricity to the machines

Answer: All expenses, except “The cost incurred in advertising features of the components” and “The cost incurred in providing electricity to the machines”, will determine the original acquisition cost.

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